Unemployment Jumps: The Battle of the Circles

One thing we’ve learned (or relearned) in recent years is that economic policy is largely about circles: creating virtuous circles and avoiding vicious circles. For the past few months, investors have been celebrating the formation of a new virtuous circle: an extremely expansionary policy framework (record-low interest rates, a weak dollar, a hefty fiscal stimulus, and extensive Fed intervention in the credit markets) restores stability to the financial and real estate markets, which, in turn, creates more confidence among firms and consumers, giving a boost to the real economy that validates the rise in stock prices and (in some cities) home prices.

This circle is real enough, as far as it goes, and it is certainly a great improvement on the vicious circle it replaced. Turmoil in the financial and real estate markets was unnerving the typical American household and business owner, prompting a sharp drop in consumption and investment, which, in turn, was putting more downward pressure on the markets.

But today’s payroll figures from the Labor Deparment, which show that the unemployment rate climbed to 9.8 per cent in September, are a stark reminder of the dangers facing the economy from another self-reinforcing negative process—one in which joblessness and fear of joblessness prompts consumers and firms to cut back their spending, which, in turn, generates more job cuts, sending the economy into a downward spiral. This is the great economic scourge that John Maynard Keynes identified, and is therefore known as the Keynesian vicious circle.

Given the possibility of measurement error and the economy’s natural tendency to bounce around a bit, it is always dangerous to make too much of one monthly statistic. Still, the details from today’s release are sobering:

Some fifteen million able-bodied Americans who want a job are now deprived of one.

If you add in people working part-time because they can’t get full-time work, the figure rises to more than twenty-four million—more than fifteen per cent of the labor force.

About 5.4 million people—more than a third of the unemployed—have been out of work for more than six months.

Employment is still falling in most major sectors of the economy, including manufacturing, construction, and retail. (About the only bright spot is health care, which has added 559,000 jobs since the recession began in December, 2007.)

While conceding that the employment report was “disappointing,” Christine Romer, head of the White House Council of Economic Advisers, insisted to Bloomberg Television that “we’re moving in a good direction.” Strictly speaking, Romer was correct: most economic forecasters are predicting that the economy will expand modestly in the fourth quarter, which would mark an end to the recession.

The big question is what will happen in 2010. At the beginning of this year, when all seemed dark and dismal, I wrote a column for the late Portfolio in which I made the optimistic case. Pointing to the unprecedented policy measures that had already been taken, and the election of a new President who was promising a new stimulus package, I wrote, “By the end of this year, if all goes well, there could be tentative signs of an upturn.” Actually, I was too pessimistic: the signs of a recovery were visible by mid-year. Now, however, the outlook is murky.

Romer and other optimists, such as Jim Grant, the publisher of the Interest Rate Observer, are talking up the possibility of a vigorous upturn—a so-called “V-shaped” recovery. Pessimists, such as N.Y.U.’s Nouriel Roubini (a.k.a. “Dr. Doom”), are worried about a “W-shaped” outcome, which implies a double-dip recession.

Who is right? Quite possibly, neither of them. With rival vicious circles battling each other, the most likely outcome, perhaps, is a victory on points for the virtuous side: i.e., a modest recovery in G.D.P. that technically qualifies as an end to the recession, but which isn’t strong enough to bring down the unemployment rate much. As Ben Bernanke reiterated on Capitol Hill yesterday, this is what the Fed’s internal models are predicting, and it also jibes with the conventional wisdom view on Wall Street. Much as I dislike going with the crowd, in this instance I am, for now, a (somewhat skeptical) lemming. The payroll report, however, is a timely reminder that there are serious downside risks to the consensus view.

It also has important political implications. If, as seems likely, the unemployment situation doesn’t change much in the coming months, you can expect a clamor for another stimulus package. Some reputable and well-connected economists, such as Berkeley’s Brad De Long, are already calling for one. We already know how conservative economists will react to these calls: they will dismiss them. Going into an election year, it will be more interesting to see how Republicans in Congress act. Will they do what they did this year, which was to grumble about the concept of deficit spending but then seize as much pork for their constituents as they could? Or will they take the obstructionist route, reasoning that, come next November, bad economic news will be good for their party? We may soon find out.